From turkeys to gasoline, from clothes to dollar stores, almost every means of human activity has been exposed to the specter of inflation. All over the world, rising inflation is disrupting purchasing and spending plans.
In the face of this inflationary inferno, consumers and institutions holding fiat currency devaluations have sought alternatives to hedge against it. Bitcoin and many other cryptocurrencies are currently the weapons of choice, leading the US Securities and Exchange Commission to adopt crypto as an investable asset class.
Bitcoin has seen solid year-to-date returns, outperforming traditional hedges by rallying more than 130% compared to the tiny 4% gold. In addition, increased institutional adoption, continued appetite for digital assets based on weekly flows and increased media exposure have boosted Bitcoin’s status among weary investors.
If these are big money moves, they must be smart moves. However, while the prospect of hedging against bitcoin may seem attractive to retail investors, some lingering question marks remain about its usefulness in mitigating financial risks for individuals.
The ongoing debate about bitcoin as an inflation hedge should start with the fact that the currency is often subject to market volatility: the value of bitcoin fell by more than 80% during December 2017, by 50% in March 2020 and by another 53% in May 2021.
Bitcoin’s ability to improve user returns and reduce volatility in the long run has not been proven. Traditional hedges like gold have proven to be effective in maintaining purchasing power during periods of persistent high inflation – take the US during the 1970s as an example – something bitcoin has yet to be tested. This increased risk, in turn, makes returns vulnerable to extreme short-term fluctuations that sometimes affect the currency.
It’s too early to make judgments about bitcoin as an effective hedge.
Many make the Bitcoin argument based on the fact that it is designed for a limited supply, which supposedly protects it from devaluation compared to traditional fiat currencies. While this makes sense in theory, the price of Bitcoin has been shown to be vulnerable to external influences. Bitcoin “whales” are notorious for their ability to manipulate prices by buying or selling in bulk, which means that bitcoins can be dictated by speculative forces, not just the rule of money supply.
Another major consideration is regulation: Bitcoin and other cryptocurrencies remain at the mercy of regulators, and laws change dramatically across jurisdictions. Anti-competitive laws and short-sighted regulations can significantly impede adoption of the underlying technology, which could further reduce the price of the asset. All this to say one thing: it is too early to make judgments about Bitcoin being an effective hedge.
Catering to the rich
Against the background of this debate, another prominent trend has been driving its momentum. With the increasing popularity of Bitcoin, it continues to drive the adoption and institutionalization of the currency among consumers, including many wealthy individuals and businesses.
A recent survey found that 72% of UK financial advisors have informed their clients of investing in cryptocurrency, with nearly half of advisors saying they believe cryptocurrency can be used to diversify portfolios as an uncorrelated asset.
There has also been a significant amount of bitcoin publicity from prolific individuals who are known to be technically progressive, such as Wall Street billionaire investor Paul Tudor, Twitter CEO Jack Dorsey, the Winklevoss twins and Mike Novogratz. Even powerful companies like Goldman Sachs and Morgan Stanley have expressed interest in Bitcoin as a viable asset.
If this momentum continues, the infamous volatility of bitcoin will gradually fade as more and more wealthy and institutions hold the currency. Ironically, this accumulation of value on the network will lead to a concentration of wealth – the opposite of what Bitcoin was created for, taking into account the influence of the elite and the exclusive 1%.
In keeping with the classic schools of financial thought, this would in fact expose retail investors to greater risks, as institutional buying and selling would resemble market manipulation like whales.
Core Spirit Challenge
There is no doubt that the increasing popularity of Bitcoin will lead to more people owning it, and one could argue that the people with the most money will (as usual) end up owning the most of it.
This remarkable shift in influence toward ultra-high net worth individuals and corporations between Bitcoin and other crypto circles runs counter to the very spirit in which the Bitcoin White Paper described the peer-to-peer electronic cash system.
Among the basic rationale for cryptocurrencies is their need to be unauthorized and resistant to censorship and control by any particular institution.
Now, with the 1% seeking a larger slice of the crypto pie, they are driving up the prices of these assets in the short term in a way that traditional and less influential retail investors can’t.
While this move will undoubtedly make a few people even richer, there is an argument to be made that this could leave the market at the mercy of 1%, which goes against the intended vision of Bitcoin.